Trading financial securities can be considered a risk-reward process. Although gains can be realized (e.g., by buying a stock of a company that subsequently increases in price), losses can also be realized (e.g., buying a stock of a company that subsequently decreases in price). Thus, financial markets include inherent risks. Many strategies have been proposed to manage such risks. For example, one risk management strategy is to diversify holdings in a portfolio. Holdings may be diversified on the basis of asset type (e.g., small market capitalization vs. middle market capitalization vs. large market capitalization or value vs. growth), geographic location (e.g., United States markets vs. international markets), instrument type (e.g., stock vs. bond), and industry sector (e.g., technology vs. utilities). Another risk management strategy is to use long and short positions (e.g., long/short hedge funds). Generally, hedging may refer to the purchase or sale of a first security to reduce a risk inherent in owning a second security.
Another type of risk management strategy is a buy-write strategy. In a buy-write strategy, an investor may purchase one or more stocks and simultaneously sell (i.e., “write” call options) that correspond to the one or more stocks. The buy-write strategy has been used in indices offered by the Chicago Board Options Exchange (CBOE). In these indices, during each option period, a portfolio sells calls corresponding to 100 percent of the notional value of an underlying index (e.g., the Standard and Poor's (S&P) 500 index or the NASDAQ-100 (“N-100”) index). While a goal of the buy-write strategy is to reduce risk and to provide downside protection as compared to a conventional index fund, under some scenarios, the buy-write strategy may underperform the index during a down market, thereby failing to meet the downside protection goal.